By Anna Ringstrom and Oskar von Bahr
STOCKHOLM (Reuters) - Swedish construction company Skanska (ST:SKAb) plans to expand its commercial property development business in the United States, betting interest rates won't rise fast enough to dent strong investor demand for high-yielding real estate.
Skanska's U.S. chief Richard Cavallaro said the company's goal this year was to identify which U.S. cities were best for investment in commercial development.
"The team is out there to see what the right cities are for us. This year we'll probably know where we want to go," Cavallaro told Reuters. "The west coast and the southeast would be a great fit to our overall portfolio."
Specifically, Skanska has listed San Francisco, Los Angeles, New York, Denver, Dallas, Atlanta and Miami as potential new markets for its commercial property development.
Years of low global interest rates have pushed pension funds and other investors to look beyond bonds for assets with better yields such as real estate, and office blocks with good rental income in particular.
Aware the favorable rate backdrop for commercial real estate won't last forever, Skanska plans to increase investment in its commercial development business and broaden its geographic spread to support long-term profit growth.
Last year, commercial property investment soared 25 percent in Europe, according to consultancy Knight Frank, while consultancy CBRE said U.S. investment rose 19 percent.
"Investor demand at the moment is for good quality real estate in good locations, and let to good quality tenants so that there is a relatively good and secure income stream," CBRE research chief Nick Axford said.
Over the past five years, Skanska's commercial development has doubled its earnings to deliver nearly a third of profit, alongside its traditional construction business and two smaller divisions for infrastructure and retail property development.
Its capital gains from sales of commercial development projects in 2015 were a record 2.6 billion crowns ($322 million).
TOUGHER AHEAD?
Under a five-year plan announced in December, Skanska now wants to boost property development - residential, commercial and infrastructure - so it equals its traditional construction business, which is driven by specific client orders.
Skanska's fastest-growing commercial property market is central Europe, Poland in particular. It struck its biggest ever commercial development sale this month, a 440,000-square foot building in Boston for $452 million.
"There is great competition among investors for our projects," said Claes Larsson, global head of Skanska's commercial development, adding that buyers were mostly pension funds and property funds.
"We have no substantial slowdown in sight," he told Reuters.
The European Central Bank's key interest rate is below zero and analysts are not expecting any rises through 2017. The U.S. Federal Reserve raised rates in December for the first time in almost a decade, but has flagged only slow tightening ahead.
Larsson said he saw no risk of rates rising dramatically in the near future but once they did, investors would require better returns to stay in the market.
"We assume the market in two to three years will be weaker than today. We are extra cautious right now about factoring in today's price levels in projects we start today," he said.
Skanska's Cavallaro said in three of its four current U.S. markets - Seattle, Washington and Boston - population and job growth meant markets had remained robust, even though prices were unlikely to rise much further.
"Every major gateway city including Boston, DC and Seattle is experiencing a lot of activity and peak pricing," he said.
CBRE's Axford said while commercial property yields and prices would be affected once interest rates rise notably, prices may be supported by rents rising faster.
Some analysts see a slowdown already this year, at least in Europe.
"It seems first quarter investments will be down on last year in Europe. I think there is some caution due to wider global economic uncertainties," Knight Frank associate Matthew Colbourne said. "The question is, is it just for the quarter or is it a longer trend?".